Court cracks down on stockbrokers who bilk clients
Decision Monday rejects narrow, technical interpretations of 1930s law on financial accountability.
WASHINGTON AND NEW YORK — Crooked stockbrokers beware.
The US Supreme Court has put unscrupulous securities brokers on notice that they cannot rely on legal technicalities to escape being held accountable for defrauding their clients.
In a case that makes it easier for the Securities and Exchange Commission (SEC) to take action when brokers breach their fiduciary duty to their clients, the nation's highest court Monday unanimously ruled that courts should follow Congress's lead and broadly construe securities laws that seek to uphold high standards of business ethics.
"Among Congress' objectives in passing the [Securities and Exchange Act] was to insure honest securities markets and thereby promote investor confidence after the market crash of 1929," writes Justice John Paul Stevens for the unanimous court.
"More generally, Congress sought to substitute a philosophy of full disclosure for the philosophy of caveat emptor [buyer beware] and thus achieve a high standard of business ethics in the securities industry," Justice Stevens writes.
The decision comes at a time when brokerage houses face widespread scrutiny, and lawsuits, in the wake of a stock market bust that followed years of high-flying share prices and stock-analyst hype.
The ruling stems from the case of Charles Zandford, a broker in Maryland with the firm of Dominick & Dominick, who was convicted of defrauding an elderly client with a mentally retarded daughter of virtually all of his investment assets.
After the client, William Wood, died, there was nothing left in the account for the daughter.
Zandford maintained that he was authorized to write checks to himself from the account and that his contract permitted his receipt of virtually all of the $400,000 in assets. He was sentenced to 52 months in prison and ordered to pay $10,800 in restitution.
Following his conviction in criminal court, the SEC filed a civil action against the broker. The civil court ordered Zandford to repay $343,000 of the stolen money. Zandford appealed, arguing that the SEC regulation at issue outlaws fraud conducted "in connection with the purchase or sale of any security."
The alleged fraud that resulted in Zandford's conviction did not directly relate to the sale or purchase of securities. Rather, the assets were simply converted to Zandford's personal use.
The appeals court agreed, throwing out the order that Zandford repay the stolen funds.
In reversing that appeals court decision, the high court made clear that the securities and exchange act should be construed flexibly, not technically and restrictively.
"The SEC complaint describes a fraudulent scheme in which the securities transactions and breaches of fiduciary duty coincide," Stevens writes. "Those breaches were therefore 'in connection with' securities sales within the meaning of the [law]."
F. Joseph Warin, a partner with Gibson Dunn & Crutcher, calls the ruling "a major win for investors."
THE case is particularly important, he says, for users of so-called discretionary accounts, where individuals give the stock broker wide latitude to buy and sell securities without the need for approval from the investor. While there are no statistics on how many people use discretionary accounts, they are on the rise.
"With the complexity of society and movement and travel, discretionary accounts are a convenience, and rightfully deserve protection," says Mr. Warin, whose firm filed an amicus brief for the National Association of Securities Dealers. "So if a market is moving against an individual, a broker can execute a trade."
Had the Supreme Court not overturned the 4th Circuit court ruling, "prospective remedies for people taken advantage of by unscrupulous brokers would have been set back tremendously, especially with the growing number of older people involved in the stock market," says Stacy Canan, a lawyer for AARP.
The court's decision, she says, affirms that Congress intended for the securities markets to enjoy special protection, and that the SEC has authority to provide it.